How Do Annuities Work? The Complete Guide

Everyone wants the security of a sizable retirement fund. Saving money for retirement may seem straightforward, but with so many investment types, how can you know what to choose?

Creating a diversified portfolio can help protect your money, but choosing the right investment tools to balance your money can be tricky. If you’re still reviewing your options, you may be wondering “How do annuities work?”

Investing in an annuity helps you manage your retirement fund payout. However, you may still have questions about annuities. Read on to learn everything you need to know before investing in an annuity. 

How Do Annuities Work?

An annuity is a type of investment that offers guaranteed income paid out yearly during your retirement. Annuities are issued by insurance companies and protect you from outliving your income. These investments provide security by paying out a fixed amount of money each year based on your life expectancy. 

Annuities can also be used to pay for specific financial goals, like long-term care or estate planning. When you pay your insurance policy, the insurance company that holds your annuity promises to pay out a yearly amount for living expenses during your retirement. This low-risk, tax-deferred investment can offer you peace of mind as you age, knowing that you’ll have a regular, expected yearly budget.

If you buy an annuity with a one-time premium, it can serve similarly to a high-yield savings account until it pays out. You can also pay monthly or yearly to reach the desired investment amount. 

Types of Annuities

Most annuities offer a rate of return on your principal amount. If you choose a variable rate annuity, for example, your interest rate will change over the life of the annuity. If you choose a fixed annuity, you will agree to a return rate percentage when you start your policy. 

There are also index-linked annuities, which are connected to stock market performance. These annuities may offer higher growth potential while also protecting your annuity from market dips. 

In addition to the rate of return, you also have options on how long your annuity pays out. Certain annuities pay out for a fixed number of years, while lifetime annuities are meant to provide guaranteed lifetime income regardless of how long you live. The type of payout schedule and when you choose to start receiving payments can impact the yearly amount you will receive.

In some cases, if you need cash and do not want to continue paying commissions on your annuity, you may be able to cash in your annuity early.

Annuity vs Structured Settlement

Many people get confused about the difference between annuities and structured settlements.

Like a structured settlement, annuities pay out a lump sum over regular intervals. Additionally, there are ways to receive an early payout from both an annuity and a structured settlement. Unlike an annuity, however, structured settlements are regular payouts of a lump sum acquired from a court settlement or lawsuit. 

Immediate annuities are designed similarly to structured settlements. An immediate annuity can help you manage a lump sum of money by providing smaller yearly payouts as the rest of your investment grows.

Is an Annuity Right For You?

Figuring out your retirement plan can be tough, but knowing the answer to “How do annuities work?” can help you feel more secure. Talk to your financial advisor to see what retirement options are best for you. 

Looking for more information on how to handle your money? Check out our blog to find more business and personal finance advice!